Based on the figure, the economy is initially in long-run equilibrium at point A If there is a favorable supply shock that increases potential output and shifts the long-run aggregate supply curve from LRAS to LRAS', then the new long-run equilibrium is reached at point:

A) E
B) B
C) C
D) D

Question

Based on the figure, the economy is initially in long-run equilibrium at point A If there is a favorable supply shock that increases potential output and shifts the long-run aggregate supply curve from LRAS to LRAS', then the new long-run equilibrium is reached at point:

A) E 
B) B 
C) C 
D) D

Quizplus · Accepted Answer

The increase in potential output creates a recessionary gap in the short run as the economy is still at point A. As inflation falls, the short-run aggregate supply line shifts downward and a new long-run equilibrium is reached at point E. The long run result of an increase in potential output is a permanent increase in output and a lower inflation rate.

Based on the Figure, the Economy Is Initially in Long-Run